Add Energy Income with an MLP ETN

Ron Rowland | Thursday, May 6, 2010 at 7:30 am

This post was published 4 years, 10 months ago.

You’re probably having a tough time these days if you live off the interest from your investment portfolio. For example, according to Bankrate.com, money market accounts are now yielding a paltry 0.76 percent (nationally).

There is no big mystery why this is happening …

Ever since the banking system started blowing up back in 2008, Ben Bernanke and his Federal Reserve have kept short-term interest rates at historic lows. That’s great for bankers, terrible for savers.

Many investors are watching their income slide.

These low rates have income-investors looking for new sources of steady interest and dividends. The alternatives are few. And I’m concerned that some people are so desperate that they’re risking their principal in ways they don’t even realize!

The truth is that there is usually a direct relationship between risk and reward …

If near-absolute safety is what you want, you can get it from Treasury bills and bank savings accounts, but the interest rate will be very low.

If you must have more yield, it’s possible — as long as you’re willing to take on more risk.

In other words, there are no free lunches. The best you can do is find a happy medium somewhere on the risk-reward scale.

Today I’m going to tell you about an income investment that I think is a good balance — especially right now in this low-interest rate environment.

Master Limited Partnerships:
Energy Income

You might have heard about master limited partnerships (MLPs). They throw off nice income and have growth potential, too.

MLPs own energy pipelines and storage facilities.

MLPs do this by concentrating on the storage and transportation of energy products. After all, no matter how cheap or expensive oil may be, it still needs to get to you. And the tank farms and pipeline companies are paid well for their services.

You can, as Nilus says, invest directly in individual MLP issues. I know many people do this very successfully. There are some drawbacks, though …

For one, the tax advantages of MLPs can create some paperwork headaches. You’ll receive “K-1″ forms from each partnership. Many people find the IRS requirements aggravating when it comes time to do their tax returns.

Owning MLPs can complicate your tax return.

You can also face potential tax problems if you hold these partnerships inside an IRA or other retirement accounts. So be sure to consult a tax advisor before you put a MLP in one of these accounts.

As with individual stocks, it’s often better to diversify by holding a broad portfolio of MLPs. Of course this also multiplies the paperwork problem. So wouldn’t it be nice if you could get a whole package of MLP issues in one convenient package?

Well, now you can!

MLP ETNs:
Good Things in Nice Packages

Several exchange-traded notes, or ETNs, now track major MLP sector indexes. They give you exposure to MLP investments in a convenient package with just one trade. They also greatly streamline the income tax reporting.

Sounds great but there are some drawbacks. As I’ve written before, the ETN structure is riskier than it looks. That’s because you don’t really own the MLPs that make up the index your ETN tries to follow. What you own is a bond, issued by a bank, whose return is tied to the index.

This is called “counterparty risk.”

If your ETN sponsor should go belly-up, you could lose part or even all of your investment. Is this a big danger? No, but the possibility is real. Think about Bear Stearns and Lehman Brothers.

Whether the risk is worth taking is a personal decision for you. If you are prudently diversified and pay attention to your investments, then the counterparty risk might be acceptable.

Currently there are three ETNs to choose from that specialize in the MLP sector. You may want to consider these for the income-generating part of your portfolio.

JPMorgan Alerian MLP Index ETN (AMJ)

UBS E-TRACS Alerian MLP Infrastructure Index ETN (MLPI)

Credit Suisse Cushing 30 MLP Index ETN (MLPN)

All three of these ETNs have an attractive yield and good assortment of MLP issues. One big difference among them is that MLPN uses an equal-weighting methodology while the other two are weighted by market capitalization. This means MLPN is somewhat more diversified.

Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Nilus Mattive, Claus Vogt, Ron Rowland, Michael Larson and Bryan Rich. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Andrea Baumwald, John Burke, Marci Campbell, Selene Ceballo, Amber Dakar, Dinesh Kalera, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau, Jill Umiker, Leslie Underwood and Michelle Zausnig.

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